The Wagner Daily | April 19, 2005

Commentary:

After last week’s pounding, the broad market attempted to rebound yesterday, but volume was light and the gains were minimal. Both the S&P 500 and Nasdaq Composite attempted to rally twice during the morning session, but the lack of momentum caused both indices to merely trade sideways and close only 0.2% higher instead. Given last week’s 3.2% loss in the S&P and 4.5% loss in the Nasdaq, yesterday’s 0.2% gains were hardly impressive. Even less impressive was the Dow Jones Industrial Average, which continued to show relative weakness and closed another 0.2% lower. Total market volume in both the NYSE and Nasdaq came in 20% lighter than the previous day, which explains why the major indices failed to generate a significant reversal. After three consecutive days of higher volume selling (aka “distribution”), it’s not surprising that the first reversal attempt would occur on lighter volume. Yesterday’s light volume told us that the session was merely a technical bounce and not any sign of serious buying interest.

Throughout the month of March, we maintained a neutral bias on the broad market because trading conditions were choppy and most of the major indices were hanging out near pivotal support levels that could easily send the markets in either direction. Last week’s losses, however, caused the S&P 500, Nasdaq Composite, and Dow Jones Industrials to each fall firmly below their 200-day moving averages. When this occurs, it signals a change in overall sentiment. As such, our overall intermediate to long-term bias on the broad market has now become bearish. This, of course, does not mean we expect the broad market to fall down in a vertical fashion. Rather, it simply means we expect the overall trend to remain lower for at least the next several months. There will be pockets of individual sector strength and the broad market will obviously see an occasional rally along the way, but we feel the best risk/reward can now be found on the short side of the markets. Alternatively, sitting in cash is always a viable option if you are not yet comfortable with short selling.

In theory, a downtrending market should simply trade in an inverse technical manner as an uptrending one. However, we have learned over the years that there are indeed some major differences between the two types of markets. One big difference we have learned from previous downtrending markets is that the downward moves often occur faster and more violently than the upward moves do in an uptrending market. This means that you often need to sell short in anticipation of a downward move rather than waiting for the break of support. Otherwise, you will often miss the move entirely. Along the same line of thought, another difference we have noticed is that much of the downward moves in a downtrending market often occur in the form of overnight gaps, as opposed to intraday downtrends. If you’re swing trading on the short side, this is good for you, but it’s not ideal for traders who don’t take positions overnight.

On the other hand, there are some similarities between uptrending and downtrending markets. In a bullish market, you will often see end-of-day rallies, even if there was weakness throughout the first half of the day. Conversely, a bearish market will often succumb to an end-of-day selloff, even if the major indices were showing strength earlier in the day. This change is important to keep in mind when making your intraday trading decisions in the current environment.

As for technical chart patterns, most of them work equally well for predicting downward moves in a weak market. All you need to do is turn the charts upside down to see the probable outcome of the chart pattern. One example is the inverse behavior of consolidations on a daily chart. If, for example, the Semiconductor Index ($SOX) has been uptrending, breaks out above a key moving average, then trades sideways in a tight range for a period of days or weeks, the subsequent result is usually a rally to new highs. Conversely, the same thing works on the downside. If the $SOX has been trending lower, falls below an important moving average, then trades sideways for a few days or weeks, it usually results in a subsequent drop to new lows. The longer the period of consolidation, the more significant the subsequent move to new lows or highs will be. To illustrate this, compare the two separate daily charts of the $SOX below. The first illustrates subsequent breakout action when the index was in an uptrend, while the second illustrates the recent breakdown to new lows after the index fell below its 50-day moving averages:

If the S&P, Dow, and Nasdaq trade sideways to slightly higher for the next several days, it will result in the formation of a bearish consolidation below their respective 200-day moving averages. Such a pattern would create a low-risk opportunity for initiating new short positions in the broad-based ETFs when SPY, DIA, or QQQQ thereafter falls to new lows. The trade is considered “low risk” because the 200-day moving averages will represent a major area of resistance on any rally attempts. If, however, the major indices fail to even bounce back up to their 200-day moving averages, that shows they are even weaker than expected. Regardless, a bit of patience is required here in order to find the ideal time to sell short. Let’s watch the broad market performance today and see if it follows up to yesterday’s reversal attempt. We’ll have a better idea of when to short based on the price and volume action of the next several days. Until then, cash or a minimum number of positions is probably your safest bet.

Today’s watch list:

There are no new trade setups for today (see commentary above). We do, however, remain long PPH.

Daily Reality Report:

Below is Morpheus Trading Group’s daily
performance report of closed trades and an update on all open positions from The
Wagner Daily (Intraday Real-Time Room trades are reported separately in The
Wagner Weekly). Net P/L figures are based on the quantity of shares represented
in the MTG
Position Sizing Model.

Closed Positions:

(none)

Open Positions:

unrealized P/L = + $229

Notes:

No changes to open positions.

Edited by Deron Wagner,
MTG Founder and
President